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Insurance special purpose vehicles

Insurance special purpose vehicles (ISPVs) are special reinsurance vehicles which must be fully funded, usually by debt. The Reinsurance Directive defines an insurance special purpose vehicle as:

“any undertaking whether incorporated or not, other than an existing insurance or reinsurance undertaking, which assumes risks from insurance or reinsurance undertakings and which fully funds its exposure to such risks through the proceeds of a debt issuance or some other financial mechanism where the repayments rights of the providers of such debt or other financing mechanism are subordinated to the reinsurance obligations of such a vehicle”.

Traditionally, insurance structured finance products have been difficult to establish within Europe due to the lack of simple transformer structures that combine tax efficiency, flexible regulatory and prudential requirements. Many national regulators remain wary of insurance structured finance products as an alternative to traditional reinsurance. However, recently the insurance and capital markets have developed a number of successful hybrid products. Side cars have been created to gain access to alternative sources of capacity in a hard market. The European market may also see a rise in embedded value securitisations, reserves financing, and non-catastrophe risk transfer securitisation. The increased involvement of hedge funds and private equity funds in the insurance market (which view insurance linked securities as good diversification instruments) has also contributed to the development of such products.

By setting out harmonised rules for ISPVs, the European Commission expects to remove some of the regulatory hurdles that have prevented the insurance industry from taking full advantage of the capital markets. The Reinsurance Directive allows Member States some flexibility in designing ISPVs in their jurisdiction.

The Reinsurance Directive provides Member States with the framework to allow ISPVs to be used to provide additional reinsurance capacity. By definition such companies will need to fund their reinsurance liabilities fully through the issue of an appropriate financial instrument (e.g. debt). Once that funding is in place they will need to maintain sufficient assets to cover their liabilities. As their maximum liability will be capped at the level of their assets they should not need to hold capital or any other solvency margin. However, under the Reinsurance Directive this is a decision for the home state. From the perspective of the ceding insurance company they are protected by the fact that the liabilities are fully funded and return of the funding or any other payments are subordinated to the need to cover the insurance liabilities.

At present, in many jurisdictions, ISPVs must apply for authorisation as a reinsurer and are subject to the full regulatory regime for insurers and reinsurers. This publication is written as a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to a particular matter.